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Derivative Financial Instruments (Notes)
 9 Months Ended
Sep. 30, 2012
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments and Hedging Activities Disclosure [Text Block]
DERIVATIVE FINANCIAL INSTRUMENTS
 
Derivative financial instruments are defined as financial instruments or other contracts that contain a notional amount and one or more underlying (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets. The Company generally does not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, the Company entered into financing transactions during 2011 and the nine months ended September 30, 2012 that gave rise to derivative liabilities. These financial instruments are carried as derivative liabilities, at fair value, in the Company's financial statements. Changes in the fair value of derivative financial instruments are required to be recorded in other income in the period of change. Accordingly, all income and expense amounts discussed below are reflected in the Company's consolidated statements of operations in other income under loss on exchange and change in fair value of derivatives.

The following table summarizes the Company's activity and fair value calculations of its derivative warrants and convertible promissory notes for the nine months ended September 30, 2012.
 
Linked Common
Shares to
Derivative Warrants
Warrant
Liability
Linked Common
Shares to Promissory Notes
Compound Embedded Derivatives
Beginning balance, December 31, 2011
154,132

$
752,486

—

$
—

Issuance of promissory note with compound embedded derivative - February 3, 2012
—

—

23,416

12,151

Issuance of $75,000 promissory note with compound embedded derivative - June 6, 2012
—

—

26,042

15,625

Issuance of warrants to underwriters - September 11, 2012
110,000

49,170

—

—

Exchange of warrants for common stock
(135,782
)
(19,823
)
—

—

Change in fair value of derivatives
—

(738,628
)
623,279

56,989

Ending balance, September 30, 2012
128,350

$
43,205

672,737

$
84,765



The Company calculated the fair value of its warrant liability and compound embedded derivatives using the valuation methods and inputs described below.

Derivative Warrants
On September 11, 2012, the Company closed on a public offering of 2,200,000 shares of its common stock at an offering price of $1.00 per share and issued warrants to the underwriter to purchase 110,000 shares of common stock, which had a fair value of $49,170 (see Note 4). The Company determined that these warrants required classification as a liability and recorded this value on the balance sheet as a Warrant Liability.

In applying current accounting standards to the 153,882 warrant shares issued in the May 2011 Offering, the110,000 warrant shares issued in the September 2012 public offering (see Note 4) and the 250 warrant shares issued in July 2011 during a customer list acquisition, the Company determined that the warrants require classification as a liability due to certain registration rights and listing requirements in the agreement.

The Company recorded income resulting from the change in the fair value of the warrants during the three and nine months ended September 30, 2012 in the amount of $10,903 and $738,628, respectively. The Company recorded income resulting from the change in the fair value of the warrants during the three and nine months ended September 30, 2011 in the amount of $43,780 and $73,571, respectively.

From May through August 2012, pursuant to separate private transactions with twenty five warrant holders, the Company redeemed warrants to purchase an aggregate of 135,782 shares of common stock for the same number of shares without the Company receiving any further cash consideration. The redemptions were treated as an exchange wherein the fair value of the newly issued common stock was recorded and the difference between that and the carrying value of the warrants received in the exchange is recorded in the Company's consolidated statements of operations in other income under loss on exchange and change in fair value of derivatives. As a result of the exchange, the Company recognized a loss on the exchange of these warrants in the amount of $37,610 and $802,123 during the three and nine months ended September 30, 2012, respectively.

The derivative warrants were valued using a Binomial Lattice Option Valuation Technique (“Binomial”). Significant inputs into this technique on September 30, 2012 and 2011 are as follows:
Binomial Assumptions
September 30,
2012
 
September 30,
2011
Fair market value of asset (1)
$0.88
 
$13.20
Exercise price
$20.00
 
$20.00
Term (2)
3.6 years
 
4.6--4.9 Years
Implied expected life (3)
3.6 years
 
4.5--4.8 Years
Volatility range of inputs (4)
49.6%--70.5%
 
62.2%--93.6%
Equivalent volatility (3)
58.30%
 
75.2%
Risk-free interest rate range of inputs (5)
0.10%--0.31%
 
0.02%--0.96%
Equivalent risk-free interest rate (3)
0.19%
 
0.28%--0.33%
(1)  The fair market value of the asset was determined by the Company using all available information including, but not limited to the trading market price and the actual, negotiated prices paid by the independent investors in the May 2011 Offering and a private offering in December 2011.
 
(2)  The term is the contractual remaining term, allocated among twelve equal intervals for purposes of calculating other inputs, such as volatility and risk-free rate.
 
(3)  The implied expected life, and equivalent volatility and risk-free interest rate amounts are derived from the Binomial.
 
(4)  The Company does not have a market trading history upon which to base its forward-looking volatility. Accordingly, the Company selected peer companies that provided a reasonable basis upon which to calculate volatility for each of the intervals described in (1), above.
 
(5)  The risk-free rates used for inputs represent the yields on zero coupon US Government Securities with periods to maturity consistent with the intervals described in (1), above.
 
Compound Embedded Derivative
The Company concluded that the compound embedded derivative in its $550,000 senior secured promissory note issued on February 3, 2012 and its $75,000 convertible promissory note as modified on June 6, 2012 (see Note 2) required bifurcation and liability classification as derivative financial instruments as they were not considered indexed to the Company's own stock as defined in ASC 815, Derivatives and Hedging. The Company recorded income (expense) resulting from the change in the fair value of the compound embedded derivative during the three and nine months ended September 30, 2012 in the amount of $39,257 and $(56,989), respectively.

The Monte Carlo Simulation (“MCS”) technique was used to calculate the fair value of the compound embedded derivative because it provides for the necessary assumptions and inputs. The MCS technique, which is an option-based model, is a generally accepted valuation technique for valuing embedded conversion features in hybrid convertible notes, because it is an open-ended valuation model that embodies all significant assumption types, and ranges of assumption inputs that the Company agrees would likely be considered in connection with the arms-length negotiation related to the transference of the instrument by market participants. In addition to the typical assumptions in a closed-end option model, such as volatility and a risk free rate, MCS incorporates assumptions for interest risk, credit risk and redemption behavior. In addition, MCS breaks down the time to expiration into potentially a large population of time intervals and steps. However, there may be other circumstances or considerations, other than those addressed herein, that relate to both internal and external factors that would be considered by market participants as it relates specifically to the Company and the subject financial instruments. The effects, if any, of these considerations cannot be reasonably measured, quantified or qualified.

The following table shows the summary calculations arriving at the compound embedded derivative values as of February 3, 2012 , June 6, 2012 and September 30, 2012. See the assumption details for the composition of these calculations.
Compound Embedded Derivative
February 3,
2012
 
June 6,
 2012
 
September 30,
2012
Notional amount
$
505,785

 
$
75,000

 
$
532,808

Conversion price
21.60

 
2.88

 
0.79

   Linked common shares (1)
23,416

 
26,042

 
672,737

MCS value per linked common share (2)
0.52

 
0.60

 
0.13

   Total
$
12,151

 
$
15,625

 
$
84,765


(1) The Compound Embedded Derivative is linked to a variable number of common shares based upon a percentage of the Company's closing stock price as reflected in the over-the-counter market. The number of linked shares will increase as the trading market price decreases and will decrease as the trading market price increases. The fluctuation in the number of linked common shares will have an effect on fair values in future periods.

(2) The Note embodied a contingent conversion feature that was predicated upon a financing transaction that was planned for a date between the issuance date and March 2, 2012. If the financing occurred, the maturity date of the Note was August 2, 2012. If the financing did not occur, the maturity date of the Note was February 2, 2013. While, in hindsight, the financing did not occur, the calculation of value must consider that on the issuance date the contingency was present and resulted in multiple scenarios of outcome as it related to the conversion feature subject to bifurcation. The mechanism for building this contingency into the MCS value was to perform two separate calculations of value and weight them on a reasonable basis.


Significant inputs into the Monte Carlo Simulation used to calculate the compound embedded derivative values as of February 3, 2012, June 6, 2012 and September 30, 2012 are as follows:
 
Inception Date
 
Inception Date
 
 
Monte Carlo Assumptions
February 3,
2012
 
June 6,
2012
 
September 30,
2012
Fair market value of asset (1)
$12.50
 
$3.20
 
$0.88
Conversion price
$21.60
 
$2.88
 
$0.79
Term (2)
.5 - 1 year
 
0.60 years
 
0.34 years
Implied expected life (3)
0.74 years
 
0.58 years
 
0.34 years
Volatility range of inputs (4)
44.23%--70.30%
 
53.54%--68.00%
 
39.91%--49.84%
Equivalent volatility (3)
55.9%
 
59.2%
 
45.4%
Risk adjusted interest rate range of inputs (5)
10.00%--30.95%
 
7.62%--12.33%
 
8.18%--10.00%
Equivalent risk-adjusted interest rate (3)
16.43%
 
9.33%
 
9.19%
Credit risk-adjusted interest rate (6)
12.71%
 
15.74%
 
14.90%

(1)  The fair market value of the asset was determined by management using all available information including, but not limited to the trading market price and the actual, negotiated prices paid by a private offering in December 2011.
 
(2)  The term is the contractual remaining term, allocated among twelve equal intervals for purposes of calculating other inputs, such as volatility and risk-free rate.
 
(3)  The implied expected life, and equivalent volatility and risk-free risk-adjusted interest rate amounts are derived from the MCS.
 
(4)  The Company does not have a market trading history upon which to base its forward-looking volatility. Accordingly, the Company selected peer companies that provided a reasonable basis upon which to calculate volatility for each of the intervals described in (1), above.
 
(5) CED's bifurcated from debt instruments are expected to contain an element of market interest risk. That is, the risk that market driven interest rates will change during the term of a fixed rate debt instrument.
 
(6) The Company utilized a yield approach in developing its credit risk assumption. The yield approach assumes that the investor's yield on the instrument embodies a risk component, generally, equal to the difference between the actual yield and the yield for a similar instrument without regard to risk.